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One of the things I really like about the President's compromise on the tax bill is a temporary payroll tax “holiday”—something I have long advocated along with others such as Jamie Galbraith and Warren Mosler. The proposed deal would cut the tax by two percentage points (from the current 6.2% applied on employment income up to $106,800). The holiday is perhaps the most efficient means of providing a quick and effective stimulus, taking effect immediately, and raising weekly take-home pay for all workers. It will add about $112 billion in fiscal stimulus annually.

And since the bottom 70% of Americans pay more in payroll taxes than in federal income taxes, it provides tax relief where it is most needed. Trying to provide tax relief through income taxes automatically benefits high income earners, since they pay most of the federal income tax. There really is no other tax relief that benefits lower income Americans to a greater degree than a payroll tax cut.

Yet some have criticized the tax holiday on the argument that it puts Social Security at risk because it will be difficult to end the “holiday” by restoring the two percentage points later. They fear that when the holiday ends, workers and politicians will view restoration of the tax as a tax increase. I see that as an advantage of the holiday. We ought instead to have a permanent holiday.

What they most fear is that reduction of Social Security revenues will fuel a call to cut benefits—even though the President has promised to “replace” lost revenues with general tax revenues. While it is commonly believed that payroll taxes “pay for” Social Security benefits, that is obviously false. Sovereign government spends by crediting bank accounts, and can make its benefit payments even if the payroll tax drops to zero. In any case, what matters to our ability to take care of tomorrow's seniors is not our ability to make payments (which, by definition, can always be done) but rather is based on our ability to provide real goods and services tomorrow. All we need is a public commitment to do so.

In truth, it is an intergenerational assurance plan. Working generations agree to take care of retirees, dependents, survivors, and persons with disabilities. Currently, spouses, children, or parents of eligible workers make up more than a quarter of beneficiaries on OASDI. A large proportion will always be people without “normal” work histories who could not have made sufficient contributions to entitle them to a decent pension. Still, as a society, we have decided they should receive benefits. Further, the program is not means tested. One need only meet statutory requirements to receive benefits. Indeed, the Supreme Court has twice ruled Social Security does not make intergenerational promises to the dead, but, rather, only to their survivors. (See here; here; and here) In other words, Social Security is nothing like a private savings account—with value determined by individual contributions, and something that can be passed down to heirs.

Whether or not we can meet our public promises to tomorrow's seniors—in real terms, which are the only ones that matter-- boils down to the projection that while we have three workers today “supporting” each beneficiary, that will fall to only two workers sometime around mid-century. In real terms, that would qualify as a “crisis” if two workers in, say, 2050 were not able to produce as much as three today. Two questions follow from this. First, can we expect productivity (output per worker) to rise enough over the next half-century to ensure that two workers will, indeed, produce as much as three today? All reasonable projections—including those of the Trustees—do suppose this. Indeed, over the past half-century, productivities of workers in manufacturing have doubled or tripled, depending on the industry—far more than what is necessary to guarantee that we will have enough output in 2050 to raise the living standards of retirees, workers, and other dependents.

Second, in the unlikely event that productivity does not rise by the necessary amount, is there any purely financial change we can make to the program, including privatization, that will prevent a “crisis”? The answer is clearly no. Getting more money into the hands of the elderly (whether through public or private funding) would—at best—just mean that they would bid more of tomorrow's production away from workers and other dependents, leaving those groups worse off, whilst probably fueling inflation.

Is there another way to forestall a rising real burden—something we might do today? (www.levyinstitute.org/pubs/pn_5_06.pdf) The best approach is to follow the same policy prescriptions that would make sense even if our society were not aging: increase future productivity. That can be induced through 1) more human capital: more years of schooling, fewer dropouts, higher quality schooling, and enhanced apprenticeship and training programs; 2) more public investment: new and improved public infrastructure, better maintenance of existing infrastructure, and reduction of adverse environmental impacts; and 3) more private investment: new and improved private production facilities to enhance growth. The last item will almost certainly require maintenance of high aggregate demand today and over the near future. And in addition we need to make sure we use the resources we actually have. That means operating the economy at true full employment.

The real purpose of the payroll tax is NOT to “fund” a “pay as you go” scheme, but to prevent wage earners from consuming all the output, so something is left for those who do not work. Today we are far below full employment, so we do not need to reduce consumption of current workers—rather we need to put more people to work to produce goods and services for the elderly. If we should ever get to full employment, then we will need higher taxes. The evidence is that the US fiscal stance is actually set far too tight--anytime we get nearer to full employment, tax revenue grows above 15% per year, which inevitably slows the economy and restores a budget deficit.

And that is why we should not fear a payroll tax holiday—we need to further loosen the fiscal stance. The payroll tax holiday is the right way to relax the stance. Why discourage hiring and employment by imposing a “tax wedge” (as supply-siders call it), increasing the cost of hiring a worker and reducing take-home pay? Further, the tax is regressive—lower rates for those at the top. Remember, the purpose of the tax is to reduce consumption by income earners, to leave more goods and services for retirees. If that is the case, why exempt the rentier class (that lives on interest, rent, and profits) from this burden? If we need to reduce consumption of income earners to leave more for retirees, then we should tax all forms of income. But for the foreseeable future that is not necessary.

Meantime, enjoy your holiday!

L. Randall Wray is a Professor of Economics, University of Missouri—Kansas City. A student of Hyman Minsky, his research focuses on monetary and fiscal policy as well as unemployment and job creation. He writes a weekly column for Benzinga every Thursday.

He also blogs at New Economic Perspectives, and is a BrainTruster at New Deal 2.0. He is a senior scholar at the Levy Economics Institute, and has been a visiting professor at the University of Rome (La Sapienza), UNAM (Mexico City), University of Paris (South), and the University of Bologna (Italy).